Real Estate Mitochondria

HERE IT COMES FOLKS – WE NEVER, EVER LEARN…

I’m copying all of this excellent article from the ABC’s Alan Kohler. Read into it what you will, but really, “are you kidding me?”… Do we never learn? The Perfect Storm I’ve written about already is now definitely upon us. This rise, if you will, may be rapid in some sectors of the market but when interest rates inevitably rise, the fallout will be catastrophic. Here’s the article from ABC News Online 17 April 2014

The mortgage-backed securities market is booming and bodes well for bank competition. But it’s driving house prices higher and making it even harder for first homebuyers, writes Alan Kohler.

After five years of near death, the residential mortgage-backed securities (RMBS) market in Australia is roaring back to life, which is both good and scary.

Good because the banks might finally get some competition from non-bank lenders again; scary because the resurgent supply of prime and subprime mortgage money from yield-hungry investors is not being matched by the supply of new land to lend against, so it’s just driving house prices higher.

We are seeing two quite different markets being mixed together: one for credit that is active and plentiful (call this one nitro) and one for land that is short (call it glycerin).

In 2013, $26 billion worth of RMBS were issued in Australia, which was the most anywhere in the world, according to Deloitte partner Graham Mott. So far in 2014 the market in mortgage securities is still active, with big issues from AMP, AFG, Pepper Home Loans, Heritage Bank and Liberty.

In a speech to the Economic Society yesterday, Assistant Governor (Financial Markets) of the Reserve Bank of Australia, Guy Debelle, said: “Deal sizes have increased, especially for RMBS issued by the major banks, where the average size has increased to $2.5 billion.”

He added that issuance has picked up for the major banks as well as regional banks and non-banks (i.e. credit unions and mortgage originators), with “a number of smaller issuers returning to the market after an absence of several years”.

“RMBS … spreads, over the last year or so, have remained at their lowest level since mid 2007, despite the significantly larger volume that has been brought to market.”

A large and growing proportion of the securities are backed by non-conforming, or sub-prime loans, paying higher yields. These are about half “low doc” (not much detail on the borrower) and half to borrowers with bad credit ratings.

According to one issuer I spoke to this week, the buyers are apparently church funds, health insurance companies and state treasuries that prefer the risk/return equation of sub-prime mortgages.

But most of the RMBS being issued are AAA securities and, surprisingly, a lot of them are being bought by banks, which are, in effect, funding their competitors.

They are doing it because the furious competition, and therefore high interest rates, for retail deposits has filled their coffers and there isn’t enough demand for credit to soak it up. Buying AAA-rated mortgage securities is an easy way to make a return, even if you don’t know the end customer and can’t sell them insurance or super.

Money has been pouring into bank deposits for a few years, and now, once again, it’s pouring into the arms of “shadow banks” at lower interest rates, reminiscent of the non-bank lending boom from 2003-2007.

The typical AAA-rated RMBS issue is at 105-120 basis points above the bank bill swap rate, which is 2.7 per cent at present.

That puts the wholesale cost of funds at 10-50 basis points below retail deposit rates, and is allowing the non-bank lenders, as well as smaller banks, to gnaw away at the massive market shares of major banks.

The only problem with this idyllic scene is that all the money and lending competition is only pushing up real estate prices.

There simply isn’t enough land being released in Australia to match either the demand for housing or the supply of credit.

Bob Day, the Family First Senator-elect and one of Australia’s biggest home builders, calls it the “Baptist/bootlegger” problem.

The Baptists and the bootlegger were both in favour of prohibition for different reasons: one for misguided morality, the other to make money. He says that about 15 years ago a similar (non-collusive) coalition of environmentalists and developers formed in Australia to restrict land release.

The result, says Day, is that while the cost of building a house has come down, getting land to put it on is hard and expensive. He says that 20-30 years ago the price of a block of land was about 40 per cent of the cost of a house; now the land cost is 2-3 times the cost of a house.

The result is that instead of being three times the average wage as it used to be, the cost of housing in Australia is 6-10 times the average income. First homebuyers are now totally excluded from home ownership unless their parents support them.

It’s not a bubble – yet – because it’s merely the true forces of supply and demand working (which is the definition of a non-bubble).

Supply is restricted (of land, not houses) and demand is being fuelled by immigration and the plentiful supply of credit to investors looking to take advantage of negative gearing.

And the rejuvenation of the RMBS market will only increase the supply of credit even further and lower its price.

Next: perhaps a recommendation from the Financial System Inquiry chaired by David Murray that retirees be forced to take at last part of their super payout as a pension rather than a lump sum (so they can’t blow it on a world trip before reverting to the aged pension – which would also help take the pressure off the government-funded aged pension).

That would give another boost to the RMBS market because mortgage-backed securities are perfect investments for private annuities and pensions.

In other words, the supply of credit for mortgages, both prime and subprime, is only going in one direction – up – and it wouldn’t take another subprime mortgage bubble to produce a glut of cash available to be lent against real estate.

By the far best solution would be a big increase in the supply of serviced land in the outer suburbs of Sydney and Melbourne, but it would be slow and the infrastructure would be expensive – too expensive for the first homebuyers themselves to pay, or for governments for that matter.

Will the Coalition Government regulate the supply of credit or restrict negative gearing? Unlikely.

So it looks like your super will have to go towards buying the kids a house: they’ll never be able to afford one.